Adam Smith's Lost Legacy

GavinK9 AT gmail DOT com

Wednesday, February 28, 2007

Beware Doctrinal Purity as Adam Smith Did

P J O’Rourke’s version of Adam Smith’s Wealth Of Nations generally has had a good reception in main stream media. I haven’t got round to reading mine yet. I’m saving it for April when I am hope to be nearing the end of writing my version, which may not concur entirely with “P.J.’s”, but it has had some good reviews and if it gets people interested in finding out more, all well and good.

Over at ‘Division of Labour’, a Blog by serious economists worth reading regularly, two of them, Michael Munger and Lawrence H. White, have offered brief criticisms.

Michael Munger writes:

“Just finished reading PJ O'Rourke's new book, on Adam Smith's Wealth of Nations.A disappointment. To be fair, I am a really, really big fan of both O'Rourke and of Smith, so my hopes were perhaps unrealistically high.

But Smith is subtle, and it is hard to understand his main thesis on division of labor. PJ apparently doesn't, or at least skips over it any real discussion. He wastes chapters paraphrasing Smith's language, instead of summarizing his ideas.

And Lawrence H. White adds:

“Like Mike Munger, I recently finished reading P. J. O’Rourke’s On the Wealth of Nations. And like Mike, I was disappointed. I’m teaching undergrad History of Economic Thought this semester and I was hoping the book might be worth assigning. But it’s not really suitable. The book’s strong suit is its humor, but many of the jokes will be over the head of undergrad readers, most of whom (one must assume) aren’t already familiar with the subject.

Even more fatally, there are too many economic and doctrine-historical errors in the book. Fixing these would not have made the book any less funny. I wish P. J. or his editor had had the good sense to hire a few economists to vet the manuscript. If they had, we wouldn’t have to wince at amateurish misstatements.”

CommentI would have liked Michael Munger to explain a bit about O’Rourke’s misunderstanding of the significance of Smith’s ‘main thesis of the division of labour’ – it certainly is a central idea of Smith’s political economy and it is an error to which many in the profession also committed over the 19th and 20th centuries (including such as Murray Rothbard, whom I have criticized on Lost Legacy in detail).

The short examples given by Lawrence H. White of errors about monetary theory and banking were most useful, though I might have reservations about White’s unelaborated upon views that:

That would depend upon just how much disruption you are prepared to tolerate while an economy adjusted to new changes that in longer term made sense, but which in the short term caused considerable personal misery to families caught up in them. In 18th-century Scotland, there were no margins for errors, no safety nets and no relief from utter destitution when things went wrong. And when they went wrong, people died, especially children.

Smith in this, and in regard to many other doctrinally sound economic practices (even tariff reform) considered that ‘humanity required’ a more cautious approach, which, where possible, mitigated the spillovers from doctrinal purity.

Tuesday, February 27, 2007

Explanation, Yes; Prediction, No

There is nothing wrong with being ‘self-taught’ if the output is as good or better than being tutor-taught. Then everything depends on the tutor, which may be marginally better or worse than being self-taught; but everything then depends on by which instruments of learning you are self-taught?

Ranjit S. Mathoda on his Blog: Mathoda.com (‘the art and observations of…)’, says he ‘taught himself quite a bit of economics’ (26 February), and he plunges in with:

“Adam Smith is widely credited as the father of economics, but he would not have considered himself to be an economist. He was considered in his time to be a moral philosopher. He was interested in human behavior generally, and used certain techniques to help him understand and predict behavior. Modern economists like Gary Becker and Stephen Leavitt have applied the tools of economics to areas as varied as family dynamics, or the naming of babies.”

CommentRanjit’s pretty good on Adam Smith as a moral philosopher and his not considering himself an economist – there was no discipline called economics in his day – but is in an error with: “He was interested in human behaviour generally, and used certain techniques to help him understand and predict behaviour.”

I do not think Smith attempted to ‘predict’ behaviour. He was in the explanation, not the prediction, business, a far more modest goal, though difficult enough. Smith looked backwards into events and history and also looked outside his window; he used his model of political economy to analyse what factors enhanced the employment of productive labour as a proportion of total employment (the rest being unproductive labour) and derived from this how far short the past and current employment of labour was from what it would have been under Perfect Liberty.

This is the extent of his aspirations in Wealth of Nations, a case study of the history of the false mercantile doctrines prevalent for many decades before 1776. We should always remember that Smith did not propose that the necessary and valuable interventions by governments should be ended (he was not a libertarian). He opposed prodigal interventions of government (wars, colonies, reckless spending and attempts to do what markets would do better), and also opposed to those mercantile and monopoly policies of misguided merchants and manufacturers, which he heavily criticised.

From his analysis of the past he suggested that because productive labour added to annual net revenue, it produced higher annual growth of the ‘necessaries, conveniences, and amusements’ of life and spread opulence, especially to the labouring poor. History showed that prodigality harmed this long term process; frugality speeded it up and kept it doing its productive work.

That modern economist took on the mantle of being in the prediction business, and rich people believed that their econometric tools could predict the future (a silly hubris upon which they wasted their money, for which some economists were truly grateful while myths about their voodoo tools lasted), is a testament to the credulity of those desperately seeking an edge in a world of uncertainty.

Explain, understand, and be thankful. That was a perfectly good enough goal for Adam Smith – it’s also better than most modern economists can aspire to, with all of their tools – and it’s good enough for me, too.

Sunday, February 25, 2007

Twighlight for Rationality?

Neoclassical economics operates on the axiom that people make rational choices (as does the Mise-ian paradigm). In the neoclassical case, rational behaviour is essential for the mathematics to produce determinate solutions. In both cases, rational behaviour has an ‘If only…’ quality. It produced some stunning analyses in the 20th century, giving its exponents grounds for the croc of gold sought by all disciplines, that of being ‘hard’, rather than ‘soft’, science.

The tension between mainstream neoclassical economics (a sub-branch of maths) and the Mise-ian minority, as firmly convinced of their scientific rectitude as the most rabid of mainstream-ers, papers over what they share: belief in rationality as the operating principle of human action.

This belief is different from Adam Smith’s, who saw human action as a vastly more complex phenomenon than people acting uni-rationally. Moral behaviour, in Smith’s world, as a moral philosopher, was driven by mixed motives within ranges of human behaviour that allowed for people acting without intentional objectives related to the outcome for society, often from degrees of fear (risk aversion) through degrees of naivety (ignorance), which nevertheless could produce unintentional outcomes of benign and malign content (the two-sided nature of this process is often forgotten by exponents of the so-called ‘invisible’, as I have mentioned several times on Lost Legacy). The ruler whose greed led him to avarice that undermined his power; the merchant whose fear led him and others like him to grow richer at the expense of society’s possibilities; the inventor whose laziness led her to higher productivity at the cost of past investments in processes she helped overthrow; and so on, are examples of the far richer behaviour range available for economists to study.

Others are noticing that something is missing in conventional economics as taught with great seriousness in the world’s universities. From a not unexpected source – from among the people whose business is to make money out of the money business - Gregory M. Drahuschak (first vice president of Janney Montgomery Scott Inc., Pittsburgh) writes “Behavioral economics may be worth looking into” in Pittsburgh Tribune-Review, (25 February):

“Although Scottish philosopher and political economist Adam Smith probably is best known for his book, "The Wealth of Nations," Smith might be remembered better for introducing the concept of behavioral economics in his 1759 book, "The Theory of Moral Sentiments." Two hundred forty-eight years later and after numerous harshly taught market lessons, Smith's work largely is ignored by a disturbingly large segment of the investing public.

Smith and others after him proposed the notion that a large portion of business and personal economic judgments are made based on the mental state of the people making the decisions. The notion largely was discredited by the middle of the last century, but recently it has resurfaced as a valid economic discipline. For some investors, however, the main lessons to be learned from the study of behavioral economics are mostly ignored.

A wide range of investors' behavior can be explained by subsets of behavioral economics. For example, why when faced with incontrovertible evidence, why do investors hang onto an investment that clearly should be liquidated? Behavioral psychologists would argue that one of the reasons is the fear of facing up to a bad decision.”

In an overly simplistic sense, the concepts of greed and fear as primary motivators are relevant. More often than not, however, it is greed, not fear, that generates the greatest problems.”

Saturday, February 24, 2007

Eamonn Butler, Director of the Adam Smith Institute, makes a poignant remark about a concern expressed by a BBC business presenter that struck an immediate resonance with my recent experience, and perhaps explains this is the way we are now:

“The lunch, by the way, featured BBC business presenter Declan Curry, who was complaining about how hard it is to get businesspeople to go on TV and defend their own business and business in general. I was not surprised. Too many businesspeople actually want to defend subsidies and regulation, rather than free markets. Frankly, I would prefer to keep them off the airwaves. Such is life.” (Eamonn Butler, ASI at: http://www.adamsmith.org/blog/)

I attended a meeting of the David Hume Institute in Edinburgh recently (I declare an interest: I am a Trustee of the DHI) where the participants were discussing how to get Scottish businesses to increase their relationships with its 14 universities and invest more in R&D (however defined).

Data were presented showing relatively poor performance by said universities and local businesses, especially SMEs, and while specific proposals were not outlined, except as goals, it struck me that some suggestions fitted the centre of gravity of current thinking among business people. They didn’t want to spend time searching among the university to find somebody who could help them (the procedures they had to go through were off-putting; it took too long and they risked ending up with somebody who didn’t understand business).

In my view, the problem for SMEs, and other enterprises, including universities which are not very enterprising, and investing in innovation is one of incentives. If you wanted to understand why SMEs do not do more than they do ion this area (most innovation is small-scale, unsung and not exceptional), you should look into their profitability, which operates under regimes of corporation tax and local business rates, imposed by legislatures, national and local, under the impression that they can extract from private sector profits without consequences to the behaviours of people in the organisations they tax.

If you add the uncertainties associated with anticipations about the future (not a problem in neoclassical economics), you would conclude that if you want this situation to change you must offer the right incentives.

Now, of course, the advisors to the legislatures, and business people too, may recognise the truth of the need for incentives, but such is the mindset of the modern adviser, that their version of ‘offer the right incentives’ is a bureaucratic one with all this implies in managed ‘tax breaks’, ‘grants’ and ‘aid’ packages.’ One such successful business leader proposed to the meeting that any package must be practical and structured within the terms of what is acceptable to the ‘politics’ of the current system, if it was to have any chance of being passed into law.

Economists, as per Adam Smith, are mindful of the practicalities involved in persuasion, when set against the standard of natural liberty. The two go together, as Smith shows repeatedly in Wealth of Nations, sometimes without drawing the point out, which causes fast modern readers to miss it. First, show how natural liberty produces an outcome; then show small practical changes that are steps towards that outcome, but do not contradict it. In other words, state how the system of natural liberty applied to the economy works and then make proposals that move the situation from where it is now to where it might move over time in the future.

His proposal was to ‘allow SMEs to retain more of their profits’. Great. It sounded quite radical: his method was to offer them tax credits, as a percentage of their tax deductions, on condition that they spent the money on employing local universities to help with R&D. This would lead to a bureaucratic mess of form filling, compliance reporting and inspecting, plus the usual proportion of ‘fraud’ as some firms tried to get round the rules, with civil servants deciding whether their expenditures (remember, out of their profits!) qualified under the tax-break rules, as if civil servants were competent to do so, or likely to do a better job than the business people who had earned the profits in the first place.

I thought about how Adam Smith might have proposed a remedy for the alleged problem that Scottish SMEs were not innovating to the same degree as in other countries (England included). First, he would have set out his ‘model’ of how an economy in a commercial society produced the ‘necessities, conveniences, and amusements of life’ each year and how it grew by net investment one year with another. He would have located the source of growth in the annual produce of the country as being generated by the productive labour in employment, defining productive as labour that added value to produce for sale in markets, the revenue from which was added to the equivalent in money terms of the annual production of the ‘necessaries, conveniences, and amusements’ of life (GDP).

Productive labour created the produce that its revenue in exchange (its money equivalent) repaid the costs of land (rents), labour (wages), and capital stock (profits). Unproductive labour does not produce this exchange because its services did not produce revenue for those who purchased them. Smith’s definitions of productive and unproductive labour were crucial to his ‘model’, though is use of them was sometimes inconsistent; it is the fact that most instances of unproductive labour did not exchange in markets that is the crucial difference with productive labour, not whether they were services per se, because some services, though their ‘products’ perished instantly, were sold in markets (such as public restaurants, coffee shops, ale houses and houses of ‘entertainment’).

Activities that exchanged products in markets did so when the factors involved in their products earned their reward, as rents, wages or profits. Entrepreneurs who made profits from their business would remain in that line of activity when they received net profits over and above the costs of the factors, including their own capital stock and their own subsistence. All charges on their net profits that reduced their incentives to continue re-investing in economic activities would undermine their willingness to sacrifice consumption and to take risks.

Taxes on profits reduce net profits; increases in business rates reduce net profits; profligate spending, including investments that fail to reproduce their costs, reduce incentives, and thereby reduce the amount available for investment and re-investment, which reduces the rate of growth of the capability for future wealth creation. Frugality, successful investments and re-investment in profitable ventures increases their incentives, and thereby increases the proportion of revenue available for investment and re-investment, which increases the rate of growth of the capability for future wealth creation.

To increase the rate of growth of future wealth creation, proposals that reduce the tax burden on the factors causing wealth creation (land, labour, and capital-stock), would be beneficial. The direct approach of legislatures, national and local, unilaterally cutting such burdens is more likely to achieve the goals of policies to increase the investment of SMEs in such activities as R&D and innovation (should such activities be related to increased future capabilities in competitive markets), than use of indirect approaches to the problem of first taxing the enterprises and then returning a proportion of taxed money in schemes that require unproductive administrative costs to decide on the suitability of individual schemes to have the taxed money returned. Entrepreneurs do not need the central direction of civil servants to take advantage of profit incentives, nor do they need administrative regimes of formal applications for eligibility, the inevitable inspection rules of compliance inspections.

To the extent that added unproductive administrative costs of compliance, which do not reproduce their costs as revenue earned in markets, reduces net profits (they have to be paid for as a charge on the employment of productive factors), they reduce the gains from returning taxed money to entrepreneurs, and undermine the demonstration effect of experimenting with the policy. I would prefer, on impeccable Smithian grounds, that more direct measures are undertaken to solve the problem.

Friday, February 23, 2007

A Small Correction of Fact

‘Would you Adam and Eve it?’ by John Thorpe, MBE, appeared in the ‘Yorkshire Evening Post’ (Leeds) yesterday. It’s about the new £20 note issued by the Bank of England, of which there is much being said in the press just now, and like the Cockney riming-slang headline (it means ‘would you believe it’), it is full of little ‘jokes’ (‘come on on, it’s a living’). It also includes a common enough error about Smith’s history:

“His abilities apparently caught the eye of the Duke of Buccleuch who engaged him as tutor to his son on his Grand Tour of Europe where Smith met other eminent thinkers such as Voltaire, Rousseau, and Franklin.”

CommentNo, John Thorpe. Smith’s abilities caught the eye of Charles Townshend, Chancellor of the Exchequer, who had married the Duke’s widow, and whose young step-son (not his son), the Duke of Buccleuch’, was at Eton. Charles Townshend wanted Smith to tutor the young Duke, and eventually acquired Smith's services as a tutor for a life pension of £300 a year in 1764.

Charles Townshend MP was a leading figure in the government at the time and is credited with single-handedly causing the American rebellion with the imposition of the tea tax, which provoked a fancy dress tea party at Boston.

Would you Adam and Eve it? A modest tax on tea imposed by his Chancellor, whom David Hume described as ‘passes for the cleverest fellow in England’, losing the King the British Empire (version 1.0). Wasn’t too clever just then, was he?

Thursday, February 22, 2007

The Moment When Brad Delong Understood What Adam Smith Was About

Every student (a status we should never lose, even unto retirement) knows the feeling; suddenly the light switches on, and you see further and deeper into a subject than you did the moment before. You are never the same again; and it happens again and again if you keep reading and researching in and around your subject.

One such ‘moment’, where the light struck (and is remembered with justified pride) occurred in the life of Brad Delong, twenty-five years ago, when still an undergraduate, and he wrote about it on his Blog yesterday.

I came across it too late last night to post, and I left it to read a chapter of Craig Smith’s new book on Adam Smith and spontaneous order. I thought about it, though, first thing this morning and wish to share it with you.

I only quote a small section of it – you MUST read it all for yourself. It concerns the time Brad Delong was searching for an original theme for his Bachelor degree final paper and was referred to a book by Keith Tribe, heavily influenced by Foucault. He titles his post with: "Two Months Before the Mast of Post-Modernism" Recycled” (those with an interest in sea stories will understand the first part of the title; those interested in literary criticism will understand the second, for the rest, those with a sense of irony will get by):

“I began to read Keith Tribe. He said very strange things. He said that the Wealth of Nations that economists read was not the Wealth of Nations that Adam Smith wrote. The Wealth of Nations that economists read was made up of two books: Book I on markets and Book II on capital. The Wealth of Nations that Adam Smith wrote was made up of five books: Book I on the "system of natural liberty," Book II on accumulation and the profits of stock, Book III on the economic history of Europe and why the empirical history of its economic development had diverged from its natural history, Book IV on the mercantile and physiocratic systems of political economy, and Book V on the proper management of the affairs of the public household by the statesman.

The Wealth of Nations, Tribe said, could not be a book of economics because a book of economics had to be about the economy. And there was no such thing as the economy in 1776 for a book of economics to be about. What was there? There was the undifferentiated stuff of the mixed social-cultural-political-trading system that governed production and distribution: material life. There was the study of the management of public finances. This was conceived in a manner analogous to the domestic-economic management of household finances. Just as--to Robert Filmer and others--the King was the father of the people, so the King's household--which became the state--had to be properly and prudently managed.

In the words of [Sir] James Steuart, who wrote his Principles of Political Oeconomy nine years before the Wealth of Nations, in 1767: "Oeconomy, in general, is the art of providing for all the wants of a family, with prudence and frugality. What oeconomy is in a family, political oeconomy is in a state." It is managing affairs to make the people prosperous and the tax collections ample by governing "in such a manner as naturally to create the reciprocal relations and dependencies between [inhabitants], so as to make their several interests lead them to supply one another with their reciprocal wants."

There wasn't, Tribe argued, an economy that an economist could write a book of economics about until the 1820s or so. …

And I became convinced that Tribe and Foucault were right. It was, indeed, only with Ricardo that the operation of what we now say is the economy--the production, exchange, and distribution of goods and services all mediated through market exchange--was seen as something that was important enough, or separate enough, or coherent enough to be something that it made sense to write books about, and, indeed, something that it made sense to be an expert in. David Ricardo was a political economist. Adam Smith was a moral philosopher. To try--as somebody like Joseph Schumpeter was--to grade Adam Smith as if he were engaged in the same intellectual project as Schumpeter was somewhat absurd.

Tribe applied this methodology to Adam Smith, his predecessors, contemporaries, and successors. What they were doing, before Ricardo, was Political Oeconomy--writing manuals of tactics and policy as advice to statesmen, although manuals restricted to what Adam Smith would have called (did call) a subclass of police: how to keep public order and create public prosperity. Hence for Adam Smith Book V of Wealth of Nations is the payoff: it tells British statesmen what they ought to do in order to make the nation prosperous, their tax coffers full, and thus the state well-funded. Book IV is a necessary prequel to Book V: it tells the statesmen in the audience why the advice that they are being given by others in other books of Political Oeconomy--by Mercantilists and Physiocrats. Book III is another necessary prequel: it teaches statesmen about the economic history of Europe and how political oeconomy of various kinds has been practiced in the past.

But Tribe's (and Foucault's) methodology collapses when we work back to Books II and I of the Wealth of Nations. For Adam Smith is not the prisoner of the discursive formation of Political Oeconomy. He is not the simple bearer of currents of thought and ideas that he recombines as other authors do in more-or-less standard and repeated ways. Adam Smith is a genius. He is the prophet and the master of a new discipline. He is the founder of economics.

Adam Smith is the founder of economics because he has a great and extraordinary insight: that the competitive market system is a remarkably powerful social calculating and organizing mechanism, and that the sophisticated division of labor to which a competitive market system backed up by secure and honest enforcement of property rights give rise is the key to the wealth of nations. Some others before had had this insight in part: Richard Cantillon writing of how once you have specified demands the market does by itself all the heavy lifting that a central planner would need to do; Bernard de Mandeville that dextrous management by a statesman can use the power of private greed to produce the benefit of public utility. But it is Smith who sees what the power of the "system of natural liberty" that is the market could be--and who follows the argument through to the conclusion that it forever upsets and overturns the previous intellectual moves made in and conclusions reached by the discursive formation of Political Oeconomy.

And once I had worked my way through to this conclusion, I could start to write my own thesis. I had broken the thralldom. Foucault's ideas of "discourse" and "archaeology" were not my masters, but my tools. And as I wrote it became very clear to me that between David Ricardo and even the later John Stuart Mill the discursive formation that was Classical Economics did not produce anybody like Adam Smith. There was nobody who made the intellectual leap--produced the epistemological break--that Smith had done that shattered Political Oeconomy and enabled the birth of Classical Economics. I could write my thesis about how the British Classical Economists never understood the Industrial Revolution that they were living through.--J. Bradford DeLong, B.A. in Social Studies summa cum laude, June 1982.

CommentThese past four or more years when I have been reading many books, papers, journals and Blogs on Adam Smith, this is the first one that I can recollect that understands what Adam Smith was about in the Wealth of Nations, and that expresses it so well. It is hard to realize this is from an undergraduate’s essay on Smith, not a doctoral or post-doctoral thesis, or a magnum opus.

Here I was, anticipating with not a little pleasure, that my book on Adam Smith for the Great Thinkers in Economics series (Palgrave-Macmillan) would set the record straight – Smith did not write a book on economics; he wrote a book that made economics possible – and Brad had concluded the same and shared it with his examiners, quietly in 1982. It was an awe struck moment for me late last night; there is no doubt in my mind that Brad Delong on Adam Smith’s role in the history of economics is absolutely right, because I in my modest way know why too.

Wednesday, February 21, 2007

18th Century Chartered Joint Stock Companies are Not the Same as Modern Corporations

Smith is good for quotes, and too good for accuracy, though. He wrote so much about the world, from distant pre-history of the past right up to the mid-to – late 18th century that out of its context, readers search apply what they find as if they are relevant to the 20th - 21st centuries.

Does it matter? Not really, but in looking at his quotes in context we learn something about what he was about, and how much or little things have changed in the intervening 217 years since he last edited Wealth of Nations and Moral Sentiments.

Steve Borsch, a serious blog author, writes a post: “Changing Nature of Work and Your Value Online” (which proffers free advice on an important subject that is entirely interesting and perhaps relevant to some of you). He posts on his Blog, “Connecting the Dots (guidance, insight & ideas in a time of accelerating change)”, and carries carries a quotation from Wikipedia:

“Think about the modern corporate organization and its just over 100 years of existence. From this Wikipedia article on the corporation comes this quote from Adam Smith's the "Wealth of Nations" which criticized the corporate form because of the separation of ownership and management.

The directors of such [joint-stock] companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own.... Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.

The modern corporate entity is, as Smith points out, an abstract one by its very nature. Remarkably complex and with numerous layers of specialized functionality, making it work as a whole is an ongoing challenge. With little true ownership by those that work within the corporate structure and loyalty (by both sides) fleeting, its no wonder that people are searching for meaning and aligned jobs while corporations are seeking human resources that provide a competitive advantage. Now throw in the explosion in instant and cheap communications, idea generation, knowledge transfer and social connections that the Internet has enabled and the corporation itself is undergoing massive shifts.Now throw in the disruption of outsourcing, specializations that perish and retraining that takes years -- coupled with the masses that are working in jobs that pay the rent but are misaligned with what each view their mission, values and purpose to be, and you have a climate ripe for disruption and change.”

CommentIt is common to find this passage, and other from the chapters round it, frequently quoted as if Smith was referring to the modern (post-19th century) joint-stock company, even identical to the modern corporation operating within ‘globalisation’. Criticism of these modern institutions should be directed at them on their own merits or demerits, without bringing Smith into it, at least not on the criteria he used.

The common form of private firm in Smith’s day was the ‘co-partnery’, which was subject to much like the ‘partnership’ law of today: each member was liable for the co-partnery’s debts up to the limit of his fortune, into bankruptcy and beyond. But the joint-stock company in law limited a member’s debt liabilities to the amount of his share value only. This allowed it to recruit subscriptions from a far-wider audience than a co-partnery; allowing it to raise vaster capital sums, because the risk, should its venture fail, to the rest of their capital and possessions was much diminished.

After that, similarities with joint-stock, modern corporations evaporated. I commented on a professor’s use of ‘international trading companies’ as if these were the same as Smith’s in a post I wrote last September from the Adam Smith conference I attended at Columbia University, New York (see archive). The same applies here, in my view.

Smith’s context was the Royal Charter trading companies, a status awarded by the King, which gave them a legal monopoly of trade with designated regions of the world to the exclusion of all others, British and foreign. The most infamous of these was the East India Company, a by-name for systematic plunder.

Chartered joint-stock companies had Courts of Governors, operating through local managers. The shareholder holders subscribed their money and received dividends; the managers managed, nominally under the supervision of the Governors, but certainly not under their day-to-day control. This problem was exacerbated by the geography of the 18th century – India was many months sailing time from London, there and back, and could take a year or more in Smith’s time. During this time, local managers made every effort to get rich quick, at the local population’s expense, and the interests of the shareholders, and collectively they used the vast sums flowing their way to bribe and corrupt wherever they found it necessary to escape close supervision (including the Directors Court, politicians, and Prime Ministers).

In these circumstances, Smith did not consider their governance to be honest. Much of his criticism against the chartered companies was directed at these aspects of their activities, unique as they were in these respects. They were not regulated as international corporations are today with legal interventions, government inquiries, a free press and media, and stronger governments around the world. Information flows in seconds from a territory that used to takes months; they are not protected by monopoly rights, they don’t have Royal Charters (an institution that still functions in the UK, in that every university is founded by a Royal Charter, but without the endemic corruption that Smith wrote of, and without the spirit of mercantile political economy, the real object of his hostility to the 18th Century joint-stock companies.

Steve Borsch is not comparing like with like. When the advantages of a join-stock company were understood in the mid-19th century, legislation was enacted that governed their behaviour, which were worlds away from Smith’s barbed statements on the ones he wrote about.

Tuesday, February 20, 2007

A man acts (Mises), so I acted (Kennedy), and Human Action followed

Today’s my birthday (thank you) and my wife wrote the following on the gift card:

‘When you first said you loved me

I truly believed it was no myth.

I thought your love would last forever,

But along came Adam Smith.’

So, spotting an entrepreneurial opportunity (the glass, at 67, is half full), I immediately suggested we went to the local ‘Canny Man’ for a ‘romantic’ lunch. The sun is shining, the sky is blue, it’s freezing cold, and I’ll manage if my Blog waits, patiently …

Tonight it’s dinner with the family at Il Castello, an Italian restorante, which we have been known to frequent on these occasions and many others.

I shall blog afterwards, good sense willing (the glass after 11 pm is empty).

In the Left Corner We Have a Rusty Idol from Calgary

Canada provides some great personalities who are worth reading as bloggers. It’s as if the people over there exaggerate the extremes of opinion to get recognised as individuals amidst the noise from their excessively noisy neighbours to the south, but no matter how much they try, they still come across (to me) as moody teenagers at a party, out to shock the uncool.

Take one such, Cliff Almas Hesby, from Calgary, Alberta, the author of the ‘Rusty Idols’ Blog, with his ‘look-at-me’ Tee-shirt slogan: ‘I am a trade barrier’ (“tee-hee, that will shock them - now how I can work in the F-word, to really upset their grandparents”), who writes a piece on Adam Smith, which shows he has not quite understood what Smith was about.

Cliff writes (and he writes well):

“Free Market ideologues love Adam Smith and his magnum opus Wealth of Nations - except for the bits that they don't.

Under capitalism the more money you have, the easier it is to make money, and the less money you have, the harder.

Wherever there is great property there is great inequality. The affluence of the rich supposes the indigence of the many.”

[Get Cliff’s idea? Society is zero-sum; capitalism has turned the planet into the mills and factories of the mid-19th century, just as Marx and Engels told us; go to Calgary and see the dank slums, the smoke stacked hellholes where the Canadian lumpen proletariat shuffle to work in their cars, their clothes made from rags, their breakfasts made from the offal thrown out by the rich, bloated capitalists living, er, next door, their deformed 6-foot tall, skinny emaciated bodies – no fear of obesity here, crippled with disease and no medical services, the nearest hospital, a dirty shed, six floors high, with ignorant, uneducated nurses and people laughingly called ‘doctors’, killing everybody the germs don’t get to first, (Editor: that’s enough make-believe): no mark]

“Smith's metaphor of the Invisible Hand is often used to justify policies of Laissez-faire absolutism, of course this is taking a very specific quote out of a very specific context of Smith's belief that national level disruptions caused by globalized trade would be restricted by specifically nationalist sympathies. Essentially, exactly the kind of thinking dismissed by globalization's current high priests as narrow and parochial.”

[At this moment he is partly quoting what others say about Adam Smith, so no point complaining: for ‘invisible hand as a metaphor’(1 mark); for ‘laissez faire absolutism’ (not a word that Smith ever used: no mark); ‘specific quote out of context’ (1 mark); ‘globalised trade’ (not a word Smith used and not appropriate in mid-18th century - international trade even with the American colonies was unimportant; Hawaii was unknown, Australia was unsettled: half mark); ‘specifically nationalist sympathies’ (no; it was simple human risk aversion to trade outside a locality and overseas – piracy, wind and waves, fraud, shipwrecks: no mark); ‘globalisation’s current high priests’ (colourful language to shock the adults: no mark)]

“Another example of the way Smith's modern followers display their very selective reading of Smith is on the subject of inheritance. Smith very strongly supported restricting inheritance, believing that beyond insuring the basic needs of widows and children it was something that distorted the equality of opportunity he believed in, creating an aristocracy of wealth. Amusingly the Adam Smith Institute now argues against the teachings of their name-sake on this and many other issues.”

[Smith’s concerns about inheritance were not directed at the overwhelming majority of Britain’s population – the labourers, artisans and their families – but at the landowners whose inheritances consisted of primogeniture rights and entails – land blocked by legal means from being broken-up and sold piecemeal; it had to be intact, as a whole, and passed to the nearest male relative, thus locking land distribution into a small coterie of rich families.

It is disingenuous to extend that to the situation today where the vast majority of Britain’s population live in families that have modest amounts of inheritance entitlements – the family home, mainly, of which the Inland Revenue takes 40 per cent, forcing the house to be sold; Smith did not believe in ‘equality’ in the sense Cliff suggests, - more like the right to a proper share in the opulence created by living in a regime of Perfect Liberty, which allowed for differences in lifetime earnings from labour; the Adam Smith Institute can look after themselves, so I offer no comments; overall score: nil.]

“Smith would probably been just as appalled by the bloated pay of CEOs and other executives and the growing canyon between the rich and poor. He would probably have supported efforts to narrow such gaps and would have sympathized with the argument that such gaps lead a dangerous class resentment and social instability. Even Bush has taken notice the dangers of such drastic transfers of wealth from the many to the few, which was the central point of his presidency of course.”

[I take the point, but it is not possible to say what Smith would have thought of these events. He did not anticipate the future, nor write about it; he did not know the word ‘capitalist’ – it was invented in 1854 and Smith died in 1790; he knew nothing of capitalism, a mid-19th century phenomenon. He certainly was concerned that if the bulk of the people – the labourers and their families – were unhappy and poor, it was ‘dangerous’ for stability, hence he approved of high wages, employment, education and freedom. The workers today are well educated, are not starving and living in hovels (I’ve been to Calgary on business and it does not look much different from Edinburgh in opulence, except everything is bigger in Calgary, but its older in Edinburgh) and they own the most amazing range of gadgetry beyond what Smith could have imagined: half mark]

“We tried it the Laissez-faire fetishists way for the last several years. The result has been an unstable mess of privilege and imbalance that threatens to upend the whole system. Time to accept that Smith's ideas always included a context of regulation and adjustment. Smith, the real Smith isn't inconsistent with regulation and adjustment - or even socialism, believers in transparent appendages to the contrary.”

[Laissez-faire is an abstract idea, never been tried nor tested, and certainly not in the ‘last several years’, and would not be a solution – Smith didn’t believe it would be either; he didn’t trust ‘merchants and manufacturers’ that much: no mark; if Cliff thinks Canada, or Calgary is on the eve of ‘revolution’, he cannot be serious, apologies to McEnroe: no mark; ‘Smith’s ideas included a context of regulation and adjustment’ – yes, but he didn’t trust politicians much either and preferred the rule of law, separation of powers and independent justice: half mark; ‘isn’t inconsistent with regulation and adjustment’ – yes: 1 mark; ‘even socialism’ – NO! Nonsense and wishful thinking, a step or more too far in Cliff’s argument, aimed at provoking adults, .. er, so I’ll calm down, with my ‘transparent appendages, whatever they are: no mark]

‘And if they are right, they are in effect arguing that fairness is impossible without radical revolutionary change.’

Well as maybe, but they ain’t right. And if ‘radical revolutionary change; is what Cliff wants, that is his free choice. In Calgary, they have democracy. If Cliff can get elected – his profile says he was a candidate for office for ‘NDP’ (of which I know nothing). All countries that have tried ‘radical revolutionary change’ have not been, even notionally, successful, except in swapping one elite for another, and making a whole lot of people, especially the average labourer and his or her family, a whole lot worse off, while they did so, and afterwards until the people returned to freedom and the rule of law.

Markets don’t promise you a rose garden, but they do quite nicely in not making you live in a man-made desert. Compare market driven Hong Kong and Mao suit, state-driven Canton before China’s steps towards liberalisation.

Overall, Cliff’s essay did not do well for content. For writing style it did much better. On Adam Smith’s thinking, he is moving away from Chicago’s version of Adam Smith, but he has some way to go to get to the heart of the Adam Smith who lived in Kirkcaldy.

Monday, February 19, 2007

The Division of Labour Has a Long Lineage, as have Markets

A Blog, ‘Associated Content: the people’s media company’, publishes today a book review by Brian McElroy, “Adam Smith in Karl Polanyi's The Great Transformation”. I contains nothing controversial with the approach of ‘Lost legacy’, though Karl Polanyi might have choked over it while eating his morning cornflakes.

Brian McElvoy opens with a paragraph that sums up the differences between Polanyi and Smith:

“In Karl Polanyi's The Great Transformation, a treatise on the economic and social consequences of the Industrial Revolution, he often invokes Adam Smith as the founder of an intellectual movement that inappropriately relegated primitive economics to prehistory by assuming that man has a natural propensity to barter, truck and exchange one thing for another. Polanyi clearly differentiates himself from this movement, largely based on one of the basic premises of the market economy; he states that "the division of labor, a phenomenon as old as society, springs from differences inherent in the facts of sex, geography, and individual endowment; and the alleged propensity of man to barter, truck and exchange is almost entirely apocryphal" (Polanyi 45).”

CommentFrom this page on (we are only at page 45), Polanyi and readers familiar with the works of Adam Smith go their separate ways. It’s some years since I last read Polanyi’s books and I remember spotting his errors in his ‘marxian’ version of the world and history, and the tendency he had to assume that Smith wrote about market relations in pre-history (and, indeed, in the ages of shepherding, farming and commerce) as if ‘truck, barter, and exchange’ on its separate, diffuse and social-evolutionary appearance within existing modes of production, meant that they dominated these ‘old’ orders and replaced them.

I have a couple of papers by Morris Silver (New York University) on these subjects, one of which is a studied and through rebuttal of Karl Polanyi’s narrow views of exchange relations in the Ancient world, using screeds of data from Greek times and earlier to show the extent and depth of what Polanyi calls peripheral, that I have not seen answered (it is among my papers in France, so I cannot give you references).

Brian McElroy does not address the substance of Polanyi’s critique, except in so far as it refers to what Smith wrote, and for this I was receptive. Polanyi came at Smith with the prejudices of a person who had taken on board the market economy, as described by Chicago, aligned it with a few quotations from Smith, and then proceeded to attack his perceptions of Smith’s political economy, as if Chicago Smith was Adam Smith inside guise of the neoclassical paradigm. Given that the neoclassical paradigm does not even describe existing economic relationships, I remain confident that Smith emerged unscathed from Polanyi's polemics against Chicago.

“As illustrated, Polanyi and Smith hold plainly different ideas on the causal factor behind the division of labor. Polanyi finds that Smith's ideas which gave rise to the notion of 'homo economicus' were more prophetic than descriptive; he states that "while up to Adam Smith's time [the propensity to barter, truck and exchange] had hardly shown up on a considerable scale in the life of any observed community, and had remained, at best, a subordinate feature of economic life, a hundred years later an industrial system was in full swing over the major part of the planet" (46).”

CommentPolanyi’s version of the division of labour is almost laughable.

Consider the simple everyday facts of life in ancient times: city states had ports; ports have ships; ships have crews; crews eat food; other people produce the food; ships carry cargo; other people produce the cargo; other people eat food; families shelter in houses; people build house; people use tools; other people make tools; tools and cargo are transported; other people transport goods, using carriages (built by others) and animals tended by others; who visit temples, built by others and managed by priests; others guard the cities; they eat food; other produce the food; and ….

There is also the extensive monetisation present in all the economies of the ancient world, and that, is the crowning evidence for the existence of the widespread division of labour: for what conceivable purpose would money exist if there was no division of labour? And before money there was barter and the same applies: 'truck, barter, and exchange' causes barter and, eventually, money, and both, eventually cause the commercial age that Smith identified, and the commercial age, in its second manfestation after the recovery of Europe from the Fall of Rome, led to the capitalist phenomenon from the mid-19th century.

How far must I go on to demonstrate the ubiquitous nature of the division of labour from ancient times, long before Plato wrote about it, never mind Petty and his watchmaker, or Diderot in his Encyclopedia, and, of course, Smith visiting the pin factory in Wealth of Nations, all of which was before the ‘industrial system’ a ‘hundred years later’.

The absence of a division of labour (which may have been preceded by the divisions associated with the sexes) describes a primitive pre-human existence (the ‘brutes’ in 18th century lore), combining absolute equality (a totem of orgasmic Marxism), with absolute poverty (another totem consequence of the socialist states of the 20th century, plus North Korea in the 21st).

Google Professor Morris Silver and follow up with his impressive scholarship on these matters.

Thanks to Brian McElvoy for reminding me of Karl Polanyi’s unsound analysis of history, and his mistakes about Adam Smith.

Sunday, February 18, 2007

End Note References Available

NOTICE re: references

Apologies, but the end note references for the previous post on Smith not having a Labour Theory of Value for Commercial Societies (capitalism was unknown to Smith and was a 19th century phenomenon) were dropped by the technical system on trasfer to the web page.

If anybody would like the 24 references to the posting, drop me a line by email to gavin at negweb doT com, and I shall send a copy back.

Smith Did Not Have a Labour Theory of Value for Commercial Society

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(AND COUNTNG) FROM HERE TO 2012 AND BEYOND, PLEASE USE THE NEW ADDRESS.

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Gavin Kennedy

I admit that reading this particular Blog (Cannonfire), I am no wiser as to its role or what it is about. Buried in an article about Abraham Lincoln and his alleged statements about corporations, I found a repetition of the usual claim that Adam Smith ‘believed’ in the labour theory of value, which has the singular virtue that it is widely believed, but no other. It is not true, especially when it is linked, as in this case, to Karl Marx.

Joseph Cannon at: ‘Cannonfire’

“Adam Smith himself voiced some wariness of "joint stock corporations," and was not (contrary to what you've been taught) always opposed to government regulation. Smith also believed in the Labor Theory of Value, usually attributed to Marx. (Yes, I've actually read The Wealth of Nations -- unlike a lot of the people who treat it as a holy book.) (Gad, I hope someone doesn't demand that I cite chapter and verse -- my complete copy is missing, and my abridged edition is buried in a huge pile of other books.)”
[Read the Cannonfire post (note, it is a fairly rabid anti-Republican rant) at:
http://cannonfire.blogspot.com/2007/02/lincoln-again.html]

Comment
I have extracted from my new book ms on Adam Smith an edited version of a sub-chapter on Smith’s alleged labour theory of value, which I found not to be the case on a close reading of Wealth of Nations. It’s rather long but you may find in thought provoking.

Smith put forward what is claimed to be a version of the labour theory of exchangeable value, along with, it should also be noted, strong evidence of his awareness that whatever merits such a theory may have had in the distant past, consistent with conventional knowledge and his historical perspective, it was insufficient to explain the observed behaviours of prices in markets, as the history of theories of value shows . And this created one of those conundrums: to what extent was Adam Smith committed to a labour theory of value? The answer is: very weakly, if at all.

There is no doubt that Smith’s presentation of labour as ‘the real measure of the exchangeable value of all commodities’ is less than clear, partly because he muddled his presentation and straddled two quite different circumstances. In time, successor authorities resolved the problem with the new theories of marginal utility, and Marxists holding labour as a measure of value by then had marched it into a cul de sac.

Smith shows that the early history of primitive hunting societies, ‘which preceded both the accumulation of stock and the appropriation of land’, were the arena where labour was ‘the source of value’ in primitive ‘exchange’. However, with the division of labour and, crucially, the co-operation of separate property owners in commercial society, Smith clearly acknowledged that labour no longer had a unique role in determining value or price. Therefore, the errors of a labour theory of value in commercial society put forward by others does not apply to Smith’s contributions.

Smith opens with:

‘In that early and rude state of society which preceded both the accumulation of stock and the appropriation of land, the proportion between the quantities of labour necessary for acquiring different objects seems to be the only circumstance which can afford any rule for exchanging them for one another’ (emphasis added).

He clearly delimits the situation he addresses, by asserting that labour is the ‘real measure of the exchangeable value of all commodities’ in a ‘rude society’ before the ‘accumulation of stock and the appropriation of land’. After the ‘accumulation’ and ‘appropriation’ occurred, labour ceased this role.

The Age of the Hunter was unrepresentative of the Ages that followed because in all of them labour was no longer the only factor of production; farming and commerce, for instance, had multi-factor production functions, and were significantly different from the ‘rude’ state of society. In consequence, Smith (and others) explored the impact of markets on the basis of pricing variations, and he used ‘natural’ and ‘market’ price formulations explain the distribution of earnings among several factors.

In his ‘parable’ of the beaver and the deer hunters he postulated that if in a ‘nation of hunters … it usually costs twice as much labour to kill a beaver which it does to kill a deer, one beaver should naturally exchange for or be worth two deer.’

The parable applies to a ‘rude’ society only, where hunters unambiguously owned the product of their labour, leaving aside the dubious implication that in exchange they traded ‘equivalent values’, a proposition derived from medieval notions of the ‘Just’ or ‘fair’ Price’, still heard occasionally today.

Separately, Smith drew attention to the problems of determining the quantities of labour exerted by beaver and deer hunters. Despite labour being ‘the real measure of the exchangeable value of all commodities’, Smith asserts that it would be ‘difficult to ascertain’ the determinants of the quantity of labour that constituted labour’s real value because, in addition to time, other qualities enter the quantity equation, such as the degrees of hardship and the ingenuity of labour, degrees by which one hour of arduous work exceeds one hour of easy work, and one hour of a trade that cost years to become proficient in compared with a month’s unskilled industry.

In a sure recipe for argument, two hunters, tired, dirty and bloodied from their labours, understated the problems of comparability: ‘it is not easy’, he says, ‘to find any accurate measure of either hardship or ingenuity.’ While ‘some allowance is commonly made for both’, the exchange ratio would be found ‘by the higgling and bargaining of the market’, which he suggests ‘is sufficient for carrying on the business of common life’. But once ‘higgling and bargaining’ are allowed, there is no compelling reason to believe that the ‘higgling’ confined itself solely to the alleged labour (or any other) costs that the parties claimed for their products.

By generalising these conclusions to both ‘rude’ and ‘advanced’ societies, it causes confusions. Smith drew attention to the problem of ‘price’ determination by asserting how it worked:

‘In the advanced state of society, allowances of this kind, for superior hardship and superior skill, are commonly made in the wages of labour; and something of the same kind must probably have taken place in its earliest and rudest period.’

If we remember that exchangeable value, first for a ‘rude’ society, assuming an acceptable measure of quantity exists, with labour as the only factor owned by whoever exerted it, is different from exchange value when societies moved on to the ‘advanced’ state, when labour was no longer the only factor, and that others owned the other factors, everything is clear. But he switched between different modes of production, causing careless readers to miss the significance of the differences. They also missed that Smith took for granted, they knew he was talking about two separate phenomena of ‘value’ in ‘rude’ and ‘value’ in subsequent states of society, after property was invented.

Separate the muddle
He opens Chapter V with:
‘Everyman is rich or poor according to the degree in which he can afford to enjoy the necessaries, conveniences, and amusements of human life.’

He speaks here of the commercial age and not the ‘rude’ hunting age, because this definition applies after the division of labour ‘has thoroughly taken place’, and he makes the logical assertion that in this state each person supplies from his own labour only a small part of his needs and, necessarily, he must obtain what else he needs from others. In these circumstances their richness or poorness depends on the labour of others each can command by what they can ‘purchase’ from what their own labour can purchase from the products they own and which they can supply to others in exchange for the products owned by them. It is the command of other people’s products through the exchange of products that people already own (irrespective of what they cost in labour), or what they can get for what they can trade, irrespective of the supposed labour ‘embodied’, so to speak, within them, that constitutes Smith’s theory of exchangeable value. It is no longer a labour theory of value.

When labour is no longer the only factor, it ceases to be the case that what everything ‘really costs to the man who wants to acquire’ something is purely ‘the toil and trouble of acquiring it’. In commercial society, through the division of labour, he acquires what he needs by trading his surplus contribution with the owners for their surplus products. By acquiring money from contributing to the production of exchangeable surpluses he saves himself the toil and trouble of making other products he wants; he imposes the ‘toil and trouble’ of making them upon those who made them. This, after all, is the benefit of an exchange economy, with its ever-finer division of labour – we have an unimaginable increase of product variability available for exchange.

Smith’s text moves between both ‘rude’ (with an extremely limited division of labour) and commercial societies (in which the division of labour ‘has thoroughly taken place’). In the ‘rude’, single-factor society, the identity of labour with value may be sound; in commercial multi-factor, multi-owner societies, the labour of an individual lost its ‘monopoly’ of creating the ‘value’ that a person consumed, because individuals now consumed products created by multiple others in addition to the one or few they created themselves.

Smith writes of exchange relations in commercial societies, after the division of labour ‘has thoroughly taken place’, and shakes off unique measures of an individual’s labour as the sole source of value; he introduced the notion of the greater toil of making everything oneself with the lesser toil and trouble of somebody else making it for an exchange with others.

‘What is bought with money or goods is purchased by labour as much as what we acquire by the toil of our own body.’

This assertion elides one relevant point: the division of labour through exchange creates a larger range of products than individuals could make for themselves in a ‘rude’ society, before the division of labour ‘has thoroughly taken place.’ The individual in commercial societies purchases from among a vastly superior range of products. ‘Toil’ is more productive with a division of labour than without it.

‘Labour’, writes Smith, referring to ‘rude’ societies, ‘was the first price, the original purchase price that was paid for all things.’ Indeed, it was by labour that ‘all the wealth of the world was originally purchased’ and, ‘its value to those who possess it and who want to exchange it for some new productions’ is ‘precisely equal to the quantity of labour which it can enable them to purchase or command.’ Smith’s shows he had moved on from labour values:

‘But though labour be the real [i.e., historical] measure of the exchangeable value of all commodities, it is no longer how value is commonly estimated.’

Because of the difficulties involved in ascertaining the commensurability of two quantities of labour, we are back at ‘higgling and bargaining’ and, outside ‘rude’ societies, the quantity of labour is an ‘abstract notion’. In commercial societies, where the division of labour is in full effect and ‘barter ceases’ in favour of monetary exchange, people rely on the ‘palpable objects’ of the quantities of commodities.

Hence, ‘it comes to pass,’ writes Smith ‘that the exchangeable value of every commodity is more frequently estimated by the quantity of money, than by the quantity of labour or any other commodity which can be had in exchange for it.’ In short, there was no useable labour theory of exchangeable value outside the early stages of ‘rude’ society, once the division of labour became general.

Smith considered that what he enunciated was clear enough if readers properly understood the central role of ‘truck, barter, and exchange’ in a commercial economy. The problem is that despite his repeated emphasis, too few readers in practice realise his intentions.

‘Had this state continued’
I shall follow his speculative diversion where he returns to a rude society.
‘In that original state of things, which precedes both the appropriation of land and the accumulation of stock, the whole produce of labour belongs to the labourer. He has neither landlord nor master to share with him.’

Smith uses the same phrase, ‘the whole produce of labour belongs to the labourer’, no less than three times but always in connection with the original, first Age of Hunting, i.e., before the Ages of Shepherding, Farming or Commerce. It is the simple fact that the product of his labour constituted the hunter’s property. An individual had a natural or perfect right in one’s own body and when ‘trafficking with those who are willing to deal with him’ (‘liberi commercii’) all persons had a natural right of ownership in their ‘industry, labour or amusements’, when not ‘hurtful to other persons or goods’.

His parable of an exchange of arrows for a share of a hunter’s kill affected his statements that the ‘whole produce of labour belongs to the labourer’. In the exchange transaction, the arrow maker no longer ‘owns’ the ones he gives in trade, and the hunter, using the arrows he did not make, no longer is the sole source of the labour involved in whatever he kills using the arrows. The link between labour and ownership necessarily breaks the link between an individual’s labour and the supposed exchange value of a product.

If the labourer was no longer the sole owner, who owned the product using arrows made by somebody else to make a kill? The hunter was not the sole owner of the ‘whole product’ of his labour. The traded arrows and the kill belonged to the hunter, net of the share of his kill that he had ‘higgled and bargained’ for with the arrow maker; the arrows belonged to the arrow maker, minus those given in exchange for a share of the kill received for the arrows that he had higgled and bargained for: the traded arrows and the share of the kill given in exchange, no longer belong to their original producers.

Exchanging created a clear break in the ownership of the factors that produced the kill. In rude societies, ownership was inextricably linked because hunters made their own arrows and arrow makers did their own hunting, but with trade the ‘title’ of ownership changed from the bargain made between the new owners. When owners of other factors joined in producing output this was significantly different from the former situation when there was only one factor, the hunter’s labour, unambiguously owned outright by the hunter.

Truck, barter and exchange introduced multiple claims to ownership of the product. Smith’s statements that ‘the whole produce of labour belongs to the labourer’ apply only to the first age of the hunters up to the exchange of arrows (or whatever) for the product.

With the evolution of property in land the share of an individual labourer in the final product is reduced, and the contribution from materials and technology, also owned by others, further reduced the share further, because he had to pay a third or half of the product as some kind of rent. Differences between rude and commercial societies in the ownership of the ‘product of labour’ became the basis of Marx’s theory of ‘exploitation’ through the ‘surplus value’ (the amount paid to the owners of capital and materials – Smith) which Marx claimed was created by ‘workers’ and ‘belonged’ to ‘them’, collectively.

The meat that hunters gave in exchange for arrows was the ‘price’ they paid to own, or to ‘borrow’, tools that had belonged to somebody else. Land before the evolution of property was ‘free’. Because they could not both consume the entire product and ‘pay’ the producer of the other factor (they couldn’t ‘eat their cake and have it’), they consumed less of the product of their labour in order to ‘pay’ for the arrows they formerly used with their own labour to produce their entire output of kills. The items they traded from the division of labour increased the hunter’s output because more and better arrows ensured more kills (partially wounded prey escaped). With the aid of the tools they purchased, they released time formerly used to make their own arrows, which increased the discretionary time available for hunting, leisure, or whatever. In exchange for the arrows, they gave up any claim to that share of the kills that went to the arrow maker, because the arrow maker’s share of a kill unambiguously belonged to him for his arrows. Inevitable disputes over shares and ‘non-payment’ required the development of adjudication and ‘rules’ or ‘laws’ and their enforcement. Thus the history of jurisprudence commenced through numerous experimental variants.
Because primitive exchanges made those participating in them ‘better off’ (a major incentive of the division of labour and the main unintentional consequence of the propensity to ‘truck, barter and exchange’), they had a self-reinforcing effect of encouraging pair-wise exchange behaviour throughout a society. Therefore, Smith’s unique assessment of the role of ‘truck, barter and exchange’ was that it opened the social-evolutionary road that eventually leaves behind assertions that the product solely belonged to the labourer.

Smith did not spell out these consequences clearly enough and he is lumbered with a reputation for a theory that he knew no longer applied, once the division of labour from exchange was underway in the later millennia of the first Age of Hunting and thereafter, with increasing effect in the Ages of Shepherding, Agriculture, and the Age of Commerce, and since in the 19th-21st centuries. Exchanging property in the age of commerce means exchanging claims on output with the participants in production.

Components of Exchangeable Value in Advanced societies
Smith makes clear that there is a crucial difference between rude and commercial society, i.e., societies more advanced than rude societies, But he is unclear that he has leapt from barter to a monetised economy:

‘As soon as stock has accumulated in the hands of particular persons, some of them will naturally employ it in setting to work industrious people, whom they will supply with materials and subsistence, in order to make a profit by the sale of their work, or by what their labour adds to the value of the materials.’

The product of ‘complete manufacture’ is exchanged for money at a price ‘over and above the price of materials, and the wages of the workmen’ and contributes something for the ‘undertaker’, who ‘hazards’ his stock in the ‘adventure’. Workmen add value to the materials provided by the undertaker and their added value pays their wages and the cost of the materials, and the profit on both wages and materials advanced by the undertaker.

The undertaker only ‘hazards’ his stock in the ‘adventure’ if he expects to make a profit. It is the profit motive that promotes the employment of labourers; without it there is no employment. If a venture did not yield a profit, the undertaker withdraws from it at the earliest opportunity and this imperative induces the undertakers’ interest in the costs of production the world over. If the venture did not pay labourers at least their minimum subsistence they do not work for it for long; they look elsewhere for work opportunities. Buyers are not interested in the seller’s costs.

Bringing the elements together, Smith finds in the prices of all commodities that all three contributing ‘owners’ share the revenue among themselves as ‘wages of their labour, the profits of their stock or the rent of their land’, making wages, profits and rent the ‘three original sources of all revenue as well as of all exchangeable value.’ Labour is no longer the sole source of value in a commercial exchange economy. Without trumpeting it, Smith dropped ‘his’ labour theory of value because this is where his analysis led him.

Money lent to someone who employs it derives revenue, its ‘rent’ being the interest paid by the borrower. The profit from the borrower’s use of it is divided between the profit for his risks in the venture and his conduct of the enterprise, and the profit of the lender who affords the borrower the opportunity to make a profit.

Smith abandoned the pristine labour theory of value that dominated his historical account of rude society and he unambiguously asserts that ‘as in a civilised country there are but few commodities of which the exchangeable value arises from labour only, rent and profit contributing to that of the far greater part of them, so the annual produce of its labour will always be sufficient to purchase or command a much greater quantity of labour than what was employed in raising, preparing, and bringing that produce to market.’

Labourers’ families live off their (subsistence) wage incomes, leaving little or nothing for savings; the undertakers’ families live of their profits and the landlord’s families live off their rents, having a greater capacity than labourers to save. Among the latter two orders there were ‘idle’ persons of all ages, who consume from their family’s their income streams from rents or profits. The proportion between the consumption and savings of productive and unproductive, including idle, labour determines whether net annual output increases or diminishes or remains the same.

In Praise of Markets

Yet another new blog comes to my attention (my trusty searchers for references to Adam Smith worked through the night and found this one). It’s about markets and looks just great. These are often misunderstood, especially by aficionados of the neoclassical paradigm, and it is always good news to note someone who has taken a look at the phenomenon in practice.

I refer to: Reinventing the Bazaar: a natural history of markets, by John McMillan, W. W. Norton, 2006, which was spotted by Jed Chistiansen, whose blog, Mercury’s Blog: Mercury Research and Consulting blog (read it at: http://blog.mercury-rac.com/2007/02/17/a-must-read/).

Jed Christiansen writes:

“The book opens not on the New York Stock Exchange, but in the Dutch city of Aalsmeer. It is here where a huge flower marketplace is operated, and where millions of dollars worth of flowers are purchased every day in an extremely efficient manner. That the book doesn’t focus solely on standard financial markets such as the NYSE is to its credit. It talks about real-life markets throughout the world-wide economy, such as a Middle East bazaar (hence the name), fishing grounds, the deregulated California energy markets, the famed auction of additional slices of the US frequency spectrum, and many more. More importantly it examines what makes those markets work, and what is required to make those markets work.

I’m also very impressed that there is no ideology here. Some authors writing a book on this topic could tend to write either a “markets can save the world, they just need to be freed from regulation” type book, or a “markets are the cause of all the worlds’ problems” type book. It is neither, and instead discusses how markets are indeed a powerful construct, but can be both well-built and resilient or poorly-built and unfair.”

And he offers some quotes from John McMillan’s ‘Reinventing the Bazaar: a natural history of markets’, of which I quote two:

“For a market to function well, you must be able to trust most of the people most of the time; you must be secure from having your property expropriated; information about what is available where at what quality must flow smoothly; any side effects on third parties must be curtailed; and competition must be at work. A multitude of mechanisms sustain these five key requisites of effective markets. Your trust in your trading partner rests on both the formal device of the law and the informal device of reputation. Your property rights are protected by the law and, in the case of your investments, by regulation. For you to be able to take your business elsewhere, there are channels for the flow of information, so you can locate others to deal with, and there are few impediments to starting up and running firms.

A market’s design, supporting these features, may evolve from below or be imposed from above; usually there is a bit of both. A workable structure provides rewards for good behavior and checks and balances to deter bad behavior, so people act honorably while following their self-interest. When markets are well designed - but only then - we can rely on Adam Smith’s invisible hand to work, harnessing dispersed information, coordinating the economy, and creating gains from trade.”

Comment:Jed Christiansen writes that ‘Reinventing the Market’: “it lays a fantastic foundation for why prediction markets are such incredible mechanisms for forecasting and revealing information.” I am not sure what a ‘prediction market’ is, so I cannot comment, but I am skeptical about anybody in the ‘prediction’ business. If anybody could predict how a market was going to operate, she would end up with all the money in the world, or a large slice of it. Those that do make anything remotely like that sort of money, on occasion, or regularly, are gamblers, albeit well informed, and in a zero-sum business. If everybody wins, the game's over; if you win and nobody else does, somebody either ‘loses’ or ‘pays’ for your winnings.

Bargaining is different. Both parties win something that is important to them, from trading something that is of lower value. The proposition behind predicting markets is (remember, I am surmising from two words and without yet having read Reinventing Markets – I shall order it today from Amazon) the implied proposition that the outcome of prediction is more gainful than being unable to predict outcomes in markets. But I shall (and should) wait until I know more. Prices are signals about possibilities, not predictions of certainties. Markets invite responders to signals to act, to follow the signal. The outcome remains uncertain. A rising price for oil may signal that investment in oil exploration or production or stockpiling, may be profitable; it may signal 'get out of the oil business' and into substitutes. The appropiate outcome depends on what is done or not done; it is not 'predicted'.

I choose to ignore John McMillan’s sentence that includes: ‘we can rely on Adam Smith’s invisible hand to work’, on grounds that my arguments against such allusions are well known to readers of Lost legacy and I shall abstain from repeating them on this occasion (see archives).

My other concern is this sentence from the book: “A market’s design, supporting these features, may evolve from below or be imposed from above; usually there is a bit of both.” I am not sure about ‘designing’ markets – a design implies intention –and markets are not the product of a design (even a human design, let alone a deity's); they evolved by trial and error, workability and redundancy, more like water finding its own level than the putting together of cardinal elements. They are still evolving; every system of interference, usually from ‘above’ but common from ‘below' too from the participants (of which Smith wrote extensively in Wealth of Nations – the nefarious ‘merchants and manufacturers’, to which we can add also, the occasional consumer engaged in some fraud or other).

Markets are not something created long ago, which remain intact like a mechanical contrivance, an object or such like. There is a history of markets, but no archeology of them. They are what happens when people behave in a certain way – you can get markets forming in anything, anywhere, including cyber space – that exist and dissolve and re-appear, and the participants disperse and re-assemble, and move on. They work better when they are free, and the five conditions identified by Jed Christiansen operate; but even with one or more elements not present or deformed in some way, markets can still be operating at lower levels of efficiency, and still be better than central direction and control for all the reasons Jed has noticed and John McMillan, the author of Reinventing Markets, has written about in detail.

Even in totalitarian Soviet Russia, in the midst of the draconian controlled economy, ‘markets’ re-appeared like shoots on a rubble site, with illegal bartering among its local agents, supplying and demanding spare resources from each other just to keep the planning system functioning, despite the draconian penalties for doing so.

Markets are a human creation, irrepressible, resolute and pervasive. They will always exist, either open and free, or underground and repressed, as long as humans exist. As Smith put it, if it was necessary for Perfect Liberty to exist before human progress from barbarism to opulence could occur, there never would have been any progress.

The reason why is that markets as a human creation (not a ‘design’), even less than perfect (an impossible goal), and are better than whatever a ‘planner’ on an average day can do. Planners don’t have many ‘good days’ because they need tyrannical means to get their lumbering designed structures underway, and humans sooner or later dispel the notion that they can be moved around like wooden chess pieces (Moral Sentiments).

Friday, February 16, 2007

From Moonshine Whiskey to Green Tourism

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I never doubted that the US can (nay, will) create a market for anything, and, most important, will link a piece about it to Adam Smith. Well, as long as the link is appropriate, that’s OK with me. So following the post on moonshine whiskey, I find this on “Wheat and Weeds”, about a NYT piece on "green weddings” and was amused:

“Gather more than 150 friends and relatives at an organic farm for a pre-wedding day of hikes and environmental tours. Calculate the mileage guests will travel and offset their carbon dioxide emissions by donating to programs that plant trees or preserve rain forests.

These stories are delightful both because of the extent to which the Lefty lifestyle can parody itself, and because they're the perfect example of the market working efficiently, creatively, and unexpectedly to respond to even the most outlandish predilections of the very people who doubt the market's ability to do any such thing.

The story looks at "green" honeymoon, reports Mary Katherine Ham:

“You used to have to go camping,” said Ted Ning, the executive director of the Lohas Journal, a resource guide for businesses that serve the environmentally conscious market. “Now you have these amazing luxurious spas in Africa or Fiji. You can look at different animals while getting a massage in a tree.”

I don't mind this kind of development in these countries, by which the folks who live there can benefit and earn a living by catering to the self-absorbed honeymoon plans of Western environmentalists. That's good stuff, economically speaking, but aren't environmentalists generally opposed to it? Until they need somewhere to go on their honeymoons that'll produce the requisite number of Peace Corps-style photo ops to please their friends back home, I guess.

It is delicious, all these folks who fancy they're dropping "off the grid" with organic, free-range, sustainable-farming products --they've created a market!”

Comment
Now that’s what I call a good story to brighten my day.

Though, I am slightly perplexed by the mandatory compensation for the carbon emissions by donations to plant trees. If the plane flies at all, full or empty, it emits carbon (or whatever the chemistry). How do they calculate the per head compensatory fee? Each passenger pays their share, or each pays for the whole share to allow for the inevitable free-riders?

Scheduled flights fly full or empty and anything in-between. If the ‘green minded’ fly, they pay their share, which is something towards the full carbon ‘cost’ – if they decide not to fly, and nobody who does fly on that plane pays anything, then the net cost in uncompensated carbon is larger. The imperative is to make excuses for flying as long as you, irrespective of what others do, pay compensation.

Other than the comfort of feeling good about it, or by being on a plane full of ‘green’ activists flying to a world conference on ‘green’ issues, I am not sure this will last, and the next step will be compulsion (the organiser of the trips collects from the paying travellers, or, ultimo extremis, the government imposes a green tax).

Which ideologues will blame on ‘market failure’… and (cynical me) ‘green’ organisers will decide to donate the voluntary compensatory ‘tax’ they collect to ‘green’ campaigning all over the world instead of trees, and governments will absorb into their spending.

Now last year I planted six fruit trees in the field in which my French house sits, so how many miles can I fly for that? How many must I plant this year? ... I must check through Wealth of Nations and Moral Sentiments to see if Adam Smith said anything remotely connectable to this issue.

[Read it at “Wheat and Weeds”: (http://wheatandweeds.blogspot.com/2007/02/valentine-to-adam-smith.htmlreligion, politics and the glories of home-grown tomatoes]

Wednesday, February 14, 2007

A Taste of the Hard Stuff

There some great Blogs out there (and much mortifying rubbish too) and occasionally my search for posts on Adam Smith (a 24/7 task, yes, Sir), I come across the very best in Blog journalism. Today I readan absolute gem about the unlikely subject of moonshine whiskey (US version), and, Adam Smith gets a mention too.

My knowledge of moonshine is restricted to a glass I drank many years ago on Benbecula, in the Western Islands off the mainland of Scotland (go west after that and you hit North America, or an iceberg). We were visiting the mother-in-law’s relatives and the obligatory glass was offered; after two I was very much not in control, never normally drinking whisky (nor anything else much).

This Blog is called: “Hillbilly savants”, which describes itself as:

“This blog is about our Appalachia - the real one, not the Hollywood-stereotype nor the third-world nation-esque stereotype being sold by do-gooders, or even the neo-Romantic sylvan stereotype that Rousseau would probably buy into.”

Now, that grabbed my attention and then my eyes were drawn to the following:

“Another key subject in this chapter is that it explains clearly and elegantly why Appalachian farmers, both Scotch-Irish and their neighbors who adopted this part of the Scotch-Irish tradition, often turned to moonshine. Ultimately, moonshining in the Appalachians (at least from the colonization period up through the tide or Prohibition) was a product of three converging structural elements: (1) inadequately developed transportation infrastructure, (2) the high resale value of processed corn (as liquor) versus unprocessed corn, and (3) the predominance of small, yeoman farmers (as in New England) rather than large-scale plantation-style agriculture (like that which dominated the rest of the South) thereby redoubling the relative costs of trying to rely on unprocessed goods for their monetary incomes. In other words, to paraphrase one of my favorite Scotsman (fellow by the name of Adam Smith), the moonshiners rationally interpreted their relative economic advantages and disadvantages and acted accordingly.”

CommentIt hardly needs a comment. Anything said would spoil the moment. The extracts given on the Blog cover so much that is interesting, and you will, like me, be tempted to look for the book on Amazon, and, hopefully, it should arrive next week.

Perhaps, one brief comment is in order. The sentence, “the moonshiners rationally interpreted their relative economic advantages and disadvantages and acted accordingly”.

Well, that is how markets appear to start (and probably the early ones too in pre-history). Individuals see an opportunity and act in pursuit of it. They neither realize, nor care, if what they are doing that is of great historical importance; they pursue their interests as they see them that will make them better off. That motive also encourages others to be willing to exchange something to acquire a mouthful or two of the liquid they may have tasted as a gift earlier. Nobody plans these incidents, nobody orders them. They occur naturally. Markets are like that. They emerge, if you let them.

Smith knew that, and said so. Whether he tasted the golden nectar, is not recorded, though we know he frequented the ‘Oyster Club’ in Edinburgh, where lassies of a willing disposition served food, beer and claret, and occasionally danced, and such like, and he watched the dancing and with his friends, then retired to a side-room for conversation, merriment and diversion, and put the world to rights, as philosophers do.

Tuesday, February 13, 2007

Smith on Education and Some Radical Suggestions

Following on praise for Xi Zhang’s correct use of Adam Smith’s legacy, I come across yet another example this morning. Geoffrey Manne post in the Blog: ‘Truth on the Market’, quotes from ‘Wealth of Nations’ (the famous Book V) in a debate about university funding, related to the University of Phoenix (USA):

The New York Times–shocker!–hates the University of Phoenix”

“I don’t know for certain whether UOP students maximize their utility by choosing UOP over Princteton (aka clown college, coincidentally), but there is, at a minimum, some theoretical merit to the form of organization.

Here’s what I (and Adam Smith) said on the topic once before:

Here’s Adam Smith on universities:

The endowments of schools and colleges have necessarily diminished more or less the necessity of application in the teachers. Their subsistence, so far as it arises from their salaries, is evidently derived from a fund altogether independent of their success and reputation in their particular professions.

In some universities the salary makes but a part, and frequently but a small part of the emoluments of the teacher, of which the greater part arises from the honoraries or fees of his pupils. The necessity of application, though always more or less diminished, is not in this case entirely taken away . . . and he still has some dependency upon the affection, gratitude, and favourable report of those who have attended upon his instructions . . . .

In other universities the teacher is prohibited from receiving any honorary or fee from his pupils, and his salary constitutes the whole of the revenue which he derives from his office. His interest is, in this case, set as directly in opposition to his duty as it is possible to set it.

Faculties in today’s universities are substantially insulated from both the reputational and remunerative consequences of offering poor (or exceptional) education. As direct payment by students — and, eventually, the conferring of degrees on “independent” courses of study — becomes more commonplace, this insulation will be seriously weakened, much to the likely benefit of the students.I have no doubt that UOP isn’t perfect. But it certainly mitigates some of the problems of traditional, nonprofit higher education. Perhaps a comparative institutional analysis would have been in order. The implication that UOP’s shortcomings derive necessarily from its for-profit status is both unsupported and unsupportable.”

CommentUniversity funding (and school funding, before it) is a topical issue still. Having passed beyond the stage of funding my bequests, endownments, private scholarships, and such like, in the UK the public funded route was selected. The old universities continued with elements of the past charitable funding sources, but also took up the government's gold too, and became dependent on taxpayer's money. The newer universities are too new to have accumulated sources of private funding, and had little incentive to search for other sources of funding, until recently.

With public funding comes what is called, euphemistically, ‘accountability’, otherwise known as political inference to meet the consensus of what ‘educational experts’ consider the ‘safe’ thing to do. What they do not do, or reward, is encourage institutions to experiment. There are about 107 universities in the UK, only one is private (the University of Buckingham), the rest are dependent on government funding (i.e., overall management).

Universities are trying to raise student fees, reluctantly accepted by government politicians, but capped severely to quieten resistance in their own ranks; but they have the resources, and the staff, to experiment with fully funded (no-government money) degree courses, where student demand is high.

Universities are already legal charities, they are legally permitted to form sub-charities within them, and these can be placed outside the public funding sector, given the task of raising their own finance, paying their staff whatever they consider appropriate, charging their own student fees, re-organising their course schedules, move from the regulatory 5-day week, 30 week years, and change over to 50 week years, 7 day weeks, 8 am to 10 pm days.

Not convinced? Of course not. Change everything at once? Of course not. That is the beauty of being able to experiment within the existing system on an individual scale in any of the 107 universities. Trial run the experiment, monitor the progress, allow radical changes under the control of those charged to manage the sub-charity that event show to be necessary.

That approach would be completely within Adam Smith’s legacy.

Oh, and a final point: defend excellence by measuring outputs not inputs. The opposite of who universities in the main practice - they make it difficult to get into their courses, but easier to pass through, with soft, even no, examination regimes. Instead, make it easier to get into the course; difficult to pass through. Examinations, independently invigilated, no choice of questions, and no other non-examination contributions to a pass.

It’s amazing what freedom to innovate, adapt, apply and try does to the people in markets (including surrogate versions).